Executive Summary - NECG Report On Air NZ/Qantas
Report on the Competitive Effects and Public Benefits Arising from the Proposed Alliance between Qantas and Air New
Zealand
EXECUTIVE SUMMARY
Link To Full Report (1.7MB PDF)
The Application
This is an Application by Air New Zealand Limited and Qantas Airways Limited seeking authorisation to implement the
terms of a Strategic Alliance arrangement. A separate Application seeking authorisation for Qantas to subscribe for up
to 22.5% of Air New Zealand’s voting equity is filed simultaneously with this Application. The documents underlying each
application are inter-conditional.
Associated with the transactions is the right for Qantas to have up to two directors on the board of directors of Air
New Zealand. In turn, Air New Zealand will be entitled to have one director on the board of Qantas, notwithstanding that
it is not subscribing for shares in that company. This recognises that the Strategic Alliance will require clear and
open communication between the parties. It also indicates the willingness of both airlines to take all steps to achieve
the best outcome from their shared vision for the future.
The Strategic Alliance
The Strategic Alliance creates a Joint Airline Operation network (the JAO Networks) which, once fully implemented, will
be commercially managed by Air New Zealand. However, the day to day flying operations will remain the responsibility of
each airline. All Air New Zealand flights will be part of the JAO Networks, together with all Qantas flights into,
within and departing from New Zealand. There are also extensive reciprocal rights for codesharing on each other’s
services. By way of example, this will enable Air New Zealand to obtain feeder traffic from codesharing on connecting
flights on Qantas’ Australian domestic and international networks.
In respect of the JAO Networks, the parties will co-ordinate pricing, capacity and all other aspects of the normal
business operations of an airline. The two airlines also agree, as part of the Strategic Alliance, that where it is
effective and efficient for them to do so they will also coordinate on their non-JAO networks.
Air New Zealand’s management of the JAO Networks will be supported by a Strategic Alliance Advisory Group that comprises
three representatives appointed by each airline. The decisions of that group are required to be unanimous. In simple
terms, a recommendation of the Strategic Alliance Advisory Group will only result in a change in management direction
when both Air New Zealand and Qantas agree that such a change should take place.
AL023430124 041202 1458 2 After taking into account the capacity of Air New Zealand and Qantas, each airline’s net
financial performance for the JAO Networks is compared to allow for the equitable allocation of benefits.
The Aviation Environment
The arrangements between Air New Zealand and Qantas are proposed at a time of unprecedented turmoil and mounting
pressure for restructuring and consolidation in the international aviation industry.
Losses
2001 was only the second year in the modern history of civil aviation in which international air traffic declined. In
2001, member airlines of the International Air Transport Association (IATA) recorded a collective loss of some US$18
billion. The prospect for 2002 is for significant losses to continue. The events of 11 September 2001, which resulted in
the US Government providing $US billions in loans and grants to the US industry only exacerbated already material
pressures on the long-term profitability of the aviation industry. The European industry has experienced similar
pressures. Together those two markets have already seen the bankruptcy of Sabena, Swissair and US Airways. There is
still substantial fallout to follow, with United Airlines expected to file imminently for Chapter 11 bankruptcy
protection. Other countries also have been forced to provide substantial financial support in order to maintain the
viability of their flag carriers, including New Zealand (NZ$885 million to date). Air New Zealand’s recapitalisation was
a direct result of these global pressures and the failure of Ansett, but was not directly related to the events of
September 11. In this global environment, Air New Zealand and Qantas are individually small players; even together they
represent less than 4% of the global aviation market.
Value Based Airlines (VBAs)
The ultimate failure of Ansett Australia is an example of the pressure full service airlines (FSAs) are facing from the
dramatic growth of low cost, “no frills”, point to point airlines such as Southwest, easyJet, Ryanair and Virgin Blue,
operating on short haul routes.
Airlines such as Air New Zealand and Qantas operate a network business, in which impacts on individual routes have
flow-on effects throughout the entire network. The network generally comprises a profitable “core” with less profitable
fringes that are tolerated because of the contribution they make to the core. These “network effects” make traditional
network airlines particularly susceptible to VBA entry, because the VBA enters as a “greenfield” operation with no
legacy costs, “cherry picks” the most profitable and busiest routes and, with costs already very low, commences
competition with the incumbent FSA.
Despite best efforts by FSAs to reduce costs in order to compete with the VBA model, they have generally been
unsuccessful; many costs are entrenched and others are essential to compete on long haul routes and to maintain a full
network. The FSA finds itself losing market share on the very routes that are integral to the viability of its overall
network.
The VBA has become an extremely successful business model in Europe and North America, and also in Australia where
Virgin Blue’s entry precipitated the failure of the incumbent, long established and well-branded Ansett Australia.
In summary, the lesson to be taken from the global experience is that the VBA model will inevitably find its way onto
the New Zealand domestic and trans-Tasman routes. The low barriers facing VBA entry into or expansion in Australasia,
particularly in the context of the Single Aviation Market, undoubtedly support this message. Further, absent the
Strategic Alliance, in a battle between two FSAs and a VBA, the Ansett Australia experience graphically demonstrates
that in Australasia, the weaker FSA will quickly surrender its position in the market - it is impossible to fight the
battle on both fronts.
Australasia
In September 1996, the Australian and New Zealand Governments entered into an “open skies” Memorandum of Understanding
creating a Single Aviation Market for Australasia. As a result, the airlines that operate within Australasia see their
home market as encompassing Australia, New Zealand and the trans-Tasman. However, this market is relatively small and
neither of the local geographic regions can sustain two FSAs. Despite Air New Zealand recently restructuring its
domestic operations in New Zealand as “NZ Express”, Air New Zealand still remains overall a full service airline and NZ
Express is still in many respects a full service operation, but with some costs taken out. Any attempt to remove the
remaining costs, i.e. to downsize “NZ Express” to a full VBA model, would be totally incompatible with the remainder of
Air New Zealand’s international network, rendering that remainder unsustainable.
From a business perspective, the international network is reliant on the domestic network. In that circumstance, and
despite its New Zealand cost base being relatively efficient by international standards, Air New Zealand would cease to
be the flag carrier promoting and supporting New Zealand’s tourism (6.6% of GDP) and export industries - both crucial to
New Zealand’s economy.
Why the transaction?
Qantas and Air New Zealand, absent the Strategic Alliance, face a lengthy war of attrition for supremacy of the New
Zealand based networks (i.e. domestic and key international routes from New Zealand). Air New Zealand is of the view
that it cannot afford to surrender its domestic network without facing ultimate failure. Its domestic base is the core
of its profitability, with most of its international routes feeding traffic to that domestic network.
However, the international routes are inadequately profitable other than as part of the overall network. Absent the
Strategic Alliance, the war of attrition would be unavoidable. While Air New Zealand’s domestic New Zealand routes are
profitable (assisted by international feed), those of Qantas presently are not (on a standalone basis). In order to
reverse that position, Qantas must increase its capacity in domestic New Zealand in order to provide frequency for the
higher yield passengers - expansion by Qantas is commercially rational.
The increase in capacity and resulting battle for customers will ultimately result in one of the two FSAs leaving the
New Zealand market. There is an insufficient customer base to allow two FSAs to survive. Air New Zealand is not well
placed to win that battle nor does it have the financial resources to signal to Qantas that it can successfully engage
in a long-term fight for market share.
The Strategic Alliance, while undoubtedly having competitive impacts in domestic New Zealand and on the trans-Tasman,
will avoid the need for, and the consequences of, a war of attrition. The Strategic Alliance will enable Air New Zealand
to maintain its operations both domestically and internationally. It will place both carriers on a more secure
foundation from which to manage external “shocks”, ranging from international conflicts to fuel price increases or
foreign exchange fluctuations.
A one-off equity injection, absent a robust strategy that resolves the industry problems for Air New Zealand, does not
provide an answer. Nor does an alliance with another airline, which simply expands Air New Zealand’s international
network outside of Australasia. The problem lies much closer to home. The Strategic Alliance provides the only solution.
The Strategic Alliance avoids a wasteful duplication of resources and achieves material benefits for New Zealand. In
contrast, the war of attrition and its consequences deny New Zealand the major benefits that flow from the Strategic
Alliance. Those benefits include the retention of a viable New Zealand majority owned and controlled flag carrier.
The Benefits
There is anti-competitive detriment associated with the Strategic Alliance. It is for that very reason that the two
airlines now seek authorisation from the Commission. However, the Strategic Alliance will create substantial and
demonstrable net benefits overall. The benefits to New Zealand from the Strategic Alliance, assuming VBA entry, exceed
the detriment by over NZ$1.4 billion over five years. Even assuming no VBA entry, the net benefits to New Zealand over
the same period are in excess of NZ$1.2 billion. Those benefits, tested against the future world without the transaction
(and not the world as it now is), flow from:
- increased tourism;
- increased engineering services;
- increased freight capacity;
- cost savings;
- new direct flights; and
- enhanced connectivity.
The benefits and detriments have been modelled and extensively tested in a report prepared by Network Economics
Consulting Group Pty Limited, an expert Canberra-based economic consulting group with considerable experience in network
industries. The benefits disclosed in that report clearly overwhelm the modelled detriment. On that basis, the
Applicants request the Commission to grant authorisation as sought.
ENDS